What's a Keogh plan?
Before a tax law change in 2001, Keogh plans were a popular choice for high-income self-employed people. These days, they've been largely replaced by SEP IRAs, which have the same contribution limits but much less paperwork.
Keogh plans come in two varieties:
Defined-contribution. These plans have two variations: profit-sharing and money-purchase. The profit-sharing version of the Keogh is most like the SEP; there's a ceiling on contributions - 25% of compensation, up to a maximum contribution of $49,000 in 2010 - and below that limit you can put in whatever you can spare. You also can change your contribution each year. With the money-purchase plan, you pick a percentage of income you'll contribute every year, and stick with it. If you don't, you'll owe the IRS a penalty.
Defined-benefit. This type of Keogh acts as a traditional pension plan, but for one key fact: you fund it yourself. You pick the annual pension you want, then contribute (and deduct from your taxes) whatever amount is needed to reach that goal. If you're self employed and have a high income - say you're a doctor or lawyer - this type of plan may allow you to save more for retirement than many other plans.
Keoghs can be complicated to set up, and the paperwork required if you own one is considerable. If you're interested in establishing a Keogh, consult a financial adviser.
Who can contribute to one?
Keogh plans are designed for self-employed people, as well as small-business owners and their employees. To be eligible to establish a Keogh, a small business must be a sole proprietorship, partnership or limited liability company (LLC). If you have employees, they must be allowed to participate in the plan. However, employees don't contribute to the plan - the employer must kick in the entire contribution.
When can I get access to the money?
You can begin making penalty-free withdrawals at age 59 ½. And you must take withdrawals once you reach age 70 ½. If you are still working in your 70s, you can continue contributing to a Keogh plan, but you must still take the required distributions as well.
What if I need the money before retirement?
The Keogh allows you to make early withdrawals, but penalizes you heavily for that right. Typically you'll owe taxes plus a 10% early withdrawal penalty - and you might owe state tax penalties, too.
Some exceptions do apply: You may be able to take a penalty-free early withdrawal if you have certain disabilities or medical expenses.
How should I invest the money?
Just as with an IRA, you can hold stocks, bonds, mutual funds and certificates of deposit in a Keogh plan.
When investing for a long-term goal such as retirement, you typically want to emphasize stocks, which have the best chance to generate returns that outpace inflation. Adding some bonds or cash to your mix can help reduce the overall volatility.
How do my withdrawals get taxed in retirement?
You pay regular income tax on your withdrawals in retirement. You can begin making penalty-free withdrawals at age 59 ½, although you don't have to start taking withdrawals until the year in which you turn 70 ½.
Does a Keogh plan make sense for me?
There are very few cases in which a Keogh is preferable to other types of retirement plans. If you don't have employees, for example, an individual 401(k) is likely a better choice, since it has higher contribution limits.
Before a tax law change in 2001, Keogh plans were a popular choice for high-income self-employed people. These days, they've been largely replaced by SEP IRAs, which have the same contribution limits but much less paperwork.
Keogh plans come in two varieties:
Defined-contribution. These plans have two variations: profit-sharing and money-purchase. The profit-sharing version of the Keogh is most like the SEP; there's a ceiling on contributions - 25% of compensation, up to a maximum contribution of $49,000 in 2010 - and below that limit you can put in whatever you can spare. You also can change your contribution each year. With the money-purchase plan, you pick a percentage of income you'll contribute every year, and stick with it. If you don't, you'll owe the IRS a penalty.
Defined-benefit. This type of Keogh acts as a traditional pension plan, but for one key fact: you fund it yourself. You pick the annual pension you want, then contribute (and deduct from your taxes) whatever amount is needed to reach that goal. If you're self employed and have a high income - say you're a doctor or lawyer - this type of plan may allow you to save more for retirement than many other plans.
Keoghs can be complicated to set up, and the paperwork required if you own one is considerable. If you're interested in establishing a Keogh, consult a financial adviser.
Who can contribute to one?
Keogh plans are designed for self-employed people, as well as small-business owners and their employees. To be eligible to establish a Keogh, a small business must be a sole proprietorship, partnership or limited liability company (LLC). If you have employees, they must be allowed to participate in the plan. However, employees don't contribute to the plan - the employer must kick in the entire contribution.
When can I get access to the money?
You can begin making penalty-free withdrawals at age 59 ½. And you must take withdrawals once you reach age 70 ½. If you are still working in your 70s, you can continue contributing to a Keogh plan, but you must still take the required distributions as well.
What if I need the money before retirement?
The Keogh allows you to make early withdrawals, but penalizes you heavily for that right. Typically you'll owe taxes plus a 10% early withdrawal penalty - and you might owe state tax penalties, too.
Some exceptions do apply: You may be able to take a penalty-free early withdrawal if you have certain disabilities or medical expenses.
How should I invest the money?
Just as with an IRA, you can hold stocks, bonds, mutual funds and certificates of deposit in a Keogh plan.
When investing for a long-term goal such as retirement, you typically want to emphasize stocks, which have the best chance to generate returns that outpace inflation. Adding some bonds or cash to your mix can help reduce the overall volatility.
How do my withdrawals get taxed in retirement?
You pay regular income tax on your withdrawals in retirement. You can begin making penalty-free withdrawals at age 59 ½, although you don't have to start taking withdrawals until the year in which you turn 70 ½.
Does a Keogh plan make sense for me?
There are very few cases in which a Keogh is preferable to other types of retirement plans. If you don't have employees, for example, an individual 401(k) is likely a better choice, since it has higher contribution limits.
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